10. Common Sense Options Trading Without a Computer

Can options be traded without using an option software program that displays performance graphs and calculates the Greek parameters of delta, gamma, theta and vega?

My answer is a qualified "yes." It's qualified because there are significant benefits to seeing potential outcomes graphically and to understanding how a position will respond to movement in the underlying futures, to time decay and to changes in implied volatility.

On the other hand, keeping things simple with a few basic strategies and with straightforward adjustment/closing rules can allow a trader to find and effectively manage positions. Here's the strategies and adjustment rules I'm referring to:

• Debit spreads (long an option; short a further out of the money option)

• Credit spreads (short an option; long a further out of the money option)

• Condors and butterfly spreads (call credit spread along with a put credit spread)

• Short strangles (short an out of the money put and an out of the money call)

Debit and credit spreads are directional trades with limited profit and limited loss. Maximum profit on a debit spread is the difference between the strike prices of the long and short options, and it's generally greater than the maximum loss which can be incurred since the loss is confined to the cost, or debit, of the spread. The market must move in the desired direction, however, in order to avoid losing money.

A credit spread can generally lose more than it can earn, but out of the money credit spreads will profit even if the market doesn't move in the desired direction. To be specific, it will earn a profit as long as the market doesn't move to much in the opposite direction. Possible profits equal the credit received while maximum losses equal the difference between strike prices reduced by the credit received.

It's logical to close debit and credit spreads when they either lose or earn a fixed amount.

Condors are positions consisting of credit spreads (long condors) or debit spread (short condors). Condors are merely short-term "bets" on the range within which the underlying futures contract will fall when the options expire. They also possess limited profit potential and limited loss exposure and, as such, can be closed at pre-determined profit and loss points.

Short strangles, by contrast, are positions that have open-ended loss potential and limited profits. They're desirable for traders who understand the risks of being short naked options, who choose to earn positive time decay, and who are willing to accept exposure to losses if the market moves and if implied volatility rises.

Unlike the previous positions, closing or adjusting positions is critical to manage the open-ended risk. In addition, short strangles are very sensitive to changes in implied volatility if the short options are in a deferred month.

A simple approach is to sell an out of the money call and an equally priced out of the money put. Define the dollar amount you're willing to lose, and then close the position if the total premium increases and the loss reaches that level. Likewise, define the dollar amount you're attempting to earn and close the position if the total premium decays and the profit reaches that level.

A more sophisticated way would be to buy back any short option for a loss if it rises in price by 50% and to initiate a new short strangle so that the put premium equals the call premium on the overall 3-legged position. This "buys you time" to earn positive time decay while maintaining a delta neutral stance.

"Knowledge is power and all traders can benefit by continually bolstering their knowledge base. I hope to contribute in that regard."  Paul Forchione